Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 23

Cash Flow Reporting

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How does a company How does a company obtain its cash?obtain its cash?

How does a company How does a company obtain its cash?obtain its cash?

Where does a Where does a company spend its company spend its

cash?cash?

Where does a Where does a company spend its company spend its

cash?cash?

What explains the change What explains the change in the cash balance?in the cash balance?

What explains the change What explains the change in the cash balance?in the cash balance?

Learning Objective 1Explain the purpose of cash flow information.

The purpose of the statement of cash flows is to report all major cash receipts (inflows) and cash payments (outflows) during a period.

Importance of Cash Flows

How does the business How does the business fund its operations?fund its operations?

How does the business How does the business fund its operations?fund its operations?

Does the business Does the business borrow any funds or borrow any funds or

repay any loans?repay any loans?

Does the business Does the business borrow any funds or borrow any funds or

repay any loans?repay any loans?

Does the business have Does the business have sufficient cash to pay its sufficient cash to pay its debts as they mature?debts as they mature?

Does the business have Does the business have sufficient cash to pay its sufficient cash to pay its debts as they mature?debts as they mature?

Does the business Does the business make any dividend make any dividend

payments?payments?

Does the business Does the business make any dividend make any dividend

payments?payments?

LO1

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Learning Objective 2Distinguish between operating, investing, and financing activities. The Statement of Cash Flows includes the following three sections:The Statement of Cash Flows includes the following three sections:

• Operating ActivitiesOperating Activities

• Investing ActivitiesInvesting Activities

• Financing ActivitiesFinancing Activities

The Statement of Cash Flows includes the following three sections:The Statement of Cash Flows includes the following three sections:

• Operating ActivitiesOperating Activities

• Investing ActivitiesInvesting Activities

• Financing ActivitiesFinancing Activities

InflowsInflows• Receipts from customersReceipts from customers• Cash dividends receivedCash dividends received• Interest from borrowersInterest from borrowers• OtherOther

InflowsInflows• Receipts from customersReceipts from customers• Cash dividends receivedCash dividends received• Interest from borrowersInterest from borrowers• OtherOther

OutflowsOutflows• Salaries and wagesSalaries and wages• Payments to suppliersPayments to suppliers• Taxes and finesTaxes and fines• Interest paid to lendersInterest paid to lenders• OtherOther

OutflowsOutflows• Salaries and wagesSalaries and wages• Payments to suppliersPayments to suppliers• Taxes and finesTaxes and fines• Interest paid to lendersInterest paid to lenders• OtherOther

Inflows• Selling long-term productive assets• Selling equity investments• Collecting principal on loans• Other

Inflows• Selling long-term productive assets• Selling equity investments• Collecting principal on loans• Other

OutflowsOutflows• Purchasing long-term productive Purchasing long-term productive

assetsassets• Purchasing equity investmentsPurchasing equity investments• Purchasing debt investmentsPurchasing debt investments• OtherOther

OutflowsOutflows• Purchasing long-term productive Purchasing long-term productive

assetsassets• Purchasing equity investmentsPurchasing equity investments• Purchasing debt investmentsPurchasing debt investments• OtherOther

InflowsInflows• Issuing its own equity securitiesIssuing its own equity securities• Issuing bonds and notesIssuing bonds and notes• Issuing short- and long-term liabilitiesIssuing short- and long-term liabilities

InflowsInflows• Issuing its own equity securitiesIssuing its own equity securities• Issuing bonds and notesIssuing bonds and notes• Issuing short- and long-term liabilitiesIssuing short- and long-term liabilities

OutflowsOutflows• Paying dividendsPaying dividends• Purchasing treasury stockPurchasing treasury stock• Repaying cash loansRepaying cash loans• Paying owners’ withdrawalsPaying owners’ withdrawals

OutflowsOutflows• Paying dividendsPaying dividends• Purchasing treasury stockPurchasing treasury stock• Repaying cash loansRepaying cash loans• Paying owners’ withdrawalsPaying owners’ withdrawals

LO2

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Cash flows from operating activities: [List of individual inflows and outflows] Net cash provided (used) by operating activites $ #####Cash flows from investing activities: [List of individual inflows and outflows] Net cash provided (used) by investing activites #####Cash flows from financing activities: [List of individual inflows and outflows] Net cash provided (used) by financing activites #####Net increase (decrease) in cash $ #####Cash (and equivalents) balance at beginning of period #####Cash (and equivalents) balance at end of period $ #####

Company NameStatement of Cash FlowsFor Period Ended Date

Learning Objective 3Describe the format of the statement of cash flows.

There are two acceptable methods to determine cash flows from There are two acceptable methods to determine cash flows from operating activities:operating activities:

• Direct methodDirect method

• Indirect methodIndirect method

There are two acceptable methods to determine cash flows from There are two acceptable methods to determine cash flows from operating activities:operating activities:

• Direct methodDirect method

• Indirect methodIndirect method

97.5% of all companies use 97.5% of all companies use the indirect method.the indirect method.

97.5% of all companies use 97.5% of all companies use the indirect method.the indirect method.

LO3

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East, Inc. reports $125,000 net income for the year ended December East, Inc. reports $125,000 net income for the year ended December 31, 2010. 31, 2010.

Accounts Receivable increased by $7,500 during the year and Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. Accounts Payable increased by $10,000.

During 2008, East reported $12,500 of Depreciation Expense.During 2008, East reported $12,500 of Depreciation Expense.

East, Inc. reports $125,000 net income for the year ended December East, Inc. reports $125,000 net income for the year ended December 31, 2010. 31, 2010.

Accounts Receivable increased by $7,500 during the year and Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. Accounts Payable increased by $10,000.

During 2008, East reported $12,500 of Depreciation Expense.During 2008, East reported $12,500 of Depreciation Expense.

What is East, Inc.’s Operating Cash Flow for 2010?

The indirect method is used by almost all companies. The indirect method starts with the accrual based net income and makes certain adjustments to arrive at cash flows from operating activities. The indirect method is used by almost all companies. The indirect method starts with the accrual based net income and makes certain adjustments to arrive at cash flows from operating activities.

Indirect Method Example

Learning Objective 4Prepare a statement of cash flows..

LO4

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Net income 125,000$

Deduct: Increase in accounts receivable

Cash provided by operating activities

Net income 125,000$

Deduct: Increase in accounts receivable

Cash provided by operating activities

For the indirect method, start with net income.

For the indirect method, start with net income.

Learning Objective 5Compute cash flows from operating activities using the indirect method.

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable

Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable

Cash provided by operating activities

Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

LO5

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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Cash provided by operating activities

Indirect Method Example

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Add: Increase in accounts payable 10,000 Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Add: Increase in accounts payable 10,000 Cash provided by operating activities

LO5

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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$

If we used the direct method, we would get the same $140,000 for cash provided by operating activities.

Indirect Method ExampleLO5

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Additional Information for 2010:Additional Information for 2010:• Net income was $105,000.Net income was $105,000.• Cash dividends declared and paid were $40,000.Cash dividends declared and paid were $40,000.• Bonds payable of $50,000 were redeemed for $50,000 cash.Bonds payable of $50,000 were redeemed for $50,000 cash.• Common stock was issued for $35,000 cash. Common stock was issued for $35,000 cash.

Additional Information for 2010:Additional Information for 2010:• Net income was $105,000.Net income was $105,000.• Cash dividends declared and paid were $40,000.Cash dividends declared and paid were $40,000.• Bonds payable of $50,000 were redeemed for $50,000 cash.Bonds payable of $50,000 were redeemed for $50,000 cash.• Common stock was issued for $35,000 cash. Common stock was issued for $35,000 cash.

Let’s prepare a Statement of Cash Flows for B&G Company Let’s prepare a Statement of Cash Flows for B&G Company using the indirect method.using the indirect method.

LO5

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Cash flows from operating activitiesNet income 105,000$

Adjustments to accrual-basis net income: Depreciation expense 34,000$

Increase in accounts receivable (9,000) Decrease in inventory 19,000 Decrease in accounts payable (8,000) Total adjustments 36,000

Net cash provided by operating activities 141,000 Cash flows from investing activities

B&G CompanyStatement of Cash Flows

For the Year Ended December 31, 2010

Start with accrual-basis net income.

Start with accrual-basis net income.

Add noncash expenses and losses.

Subtract noncash revenues and gains.

Add noncash expenses and losses.

Subtract noncash revenues and gains.

Then, analyze the changes in current assets and current liabilities.

Then, analyze the changes in current assets and current liabilities.

LO5

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Learning Objective 6Determine cash flows from both investing and financing activities.

Reporting of investing activities is identical under the indirect method and direct method.

Reporting of investing activities is identical under the indirect method and direct method.

Learning Objective 7Analyze the statement of cash flows.

Looking at the Statement of Cash Flows provides useful information that can help answer important questions about a company. Notice that while each of these companies had the same net change in cash, the change is composed of different sources and uses.

BMX ATV Trex

90,000$ 40,000$ (24,000)$

26,000 (48,000) (25,000)

13,000 (27,000) 15,000$ 15,000$ 15,000$

Cash Flows of Competing Companiesall numbers in thousandsCash provided (used) by operating activities

Cash provided (used) by investing activities:

Repayment of debtNet increase (decrease) in cash

Proceeds from sale of operating assetsPurchase of operating assets

Cash provided (used) by financing activities:

Proceeds from issuance of debt

LO6

LO7

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Used, along with income-based ratios, to assess company performance.Used, along with income-based ratios, to assess company performance. Used, along with income-based ratios, to assess company performance.Used, along with income-based ratios, to assess company performance.

Cash flow on Cash flow on total assetstotal assets = =

cash flow from operations cash flow from operations

Average total assetsAverage total assets

Compute and apply the cash flow on total assets ratio.Learning Objective 8

Items requiring separate disclosure include:Items requiring separate disclosure include:

• Retirement of debt by issuing equity securities.Retirement of debt by issuing equity securities.• Conversion of preferred stock to common stock.Conversion of preferred stock to common stock.• Leasing of assets in a capital lease transaction.Leasing of assets in a capital lease transaction.

Items requiring separate disclosure include:Items requiring separate disclosure include:

• Retirement of debt by issuing equity securities.Retirement of debt by issuing equity securities.• Conversion of preferred stock to common stock.Conversion of preferred stock to common stock.• Leasing of assets in a capital lease transaction.Leasing of assets in a capital lease transaction.

Noncash Investing and Financing

LO8

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Learning Objective 9 Appendix 23ACompute cash flows from operating activities using the direct method.

Balance, Jan. 1, 2010 22,000 Payments for merchandise 150,000 Receipts from customers 466,000 Payments for wages 145,000 Receipts from sale of land 25,000 Payments for interest 10,000 Receipts from stock issuance 35,000 Payments for taxes 20,000

Payments for equipment 70,000 Payments for bond retirement 50,000 Payments for dividends 40,000

Balance, Dec. 31, 2010 63,000

CashBalance, Jan. 1, 2010 22,000 Payments for merchandise 150,000 Receipts from customers 466,000 Payments for wages 145,000 Receipts from sale of land 25,000 Payments for interest 10,000 Receipts from stock issuance 35,000 Payments for taxes 20,000

Payments for equipment 70,000 Payments for bond retirement 50,000 Payments for dividends 40,000

Balance, Dec. 31, 2010 63,000

Cash

Let’s review this Cash account and determine where each of the transactions will appear on B&G’s Statement of Cash Flows.• Receipts from customers will appear in the operating section.• Receipts from sale of land will appear in the investing section.• Receipts from stock issuance will appear in the financing section.• Payments for merchandise, wages, interest and taxes will appear in the operating section.• Payments for equipment will appear in the investing section.• And finally, payments for bond retirement and dividends will appear in the financing section. Now, let’s look at a completed Statement of Cash Flows for B&G.

Let’s review this Cash account and determine where each of the transactions will appear on B&G’s Statement of Cash Flows.• Receipts from customers will appear in the operating section.• Receipts from sale of land will appear in the investing section.• Receipts from stock issuance will appear in the financing section.• Payments for merchandise, wages, interest and taxes will appear in the operating section.• Payments for equipment will appear in the investing section.• And finally, payments for bond retirement and dividends will appear in the financing section. Now, let’s look at a completed Statement of Cash Flows for B&G.

LO9

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Cash flows from operating activities Cash received from customers 466,000$

Cash paid for merchandise (150,000) Cash paid for wages (145,000) Cash paid for interest (10,000) Cash paid for taxes (20,000)

Net cash provided by operating activities 141,000 Cash flows from investing activities

Proceeds from sale of land 25,000

Purchase of equipment (70,000) Net cash used by investing activities (45,000) Cash flows from financing activities

Proceeds from issuance of common stock 35,000 Redemption of bonds (50,000) Payment of dividends (40,000)

Net cash used by financing activities (55,000) Net increase in cash 41,000 Cash, January 1, 2010 22,000 Cash, December 31, 2010 63,000$

B&G CompanyStatement of Cash Flows

For the Year Ended December 31, 2010

Notice how the transactions are properly classified based on our analysis on the previous slide. The statement also includes the cash reconciliation at the end.

LO9

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End of Chapter 23